Written by attorney Michael W. Eaton

LLC's as tax exempt entities

Pursuant to Texas Government Code Sec. 403.011(3), the Texas Comptroller of Public Accounts is charged with responsibility for determination of eligibility for exemptions for all state franchise, sales, and use taxes. In addition to the arguments set forth above, a recent development in the handling of franchise tax exemptions is useful to review. During 2003, the Comptroller has granted sales, use, and franchise tax exemptions for LLC’s which have a 501 (c)(3) organization as their sole member, if those LLC’s enact regulations which provide that the LLC will be operated in accordance with and governed by the provisions of the Texas Non-Profit Corporation Act, and its successor statute, the Texas Business Organizations Code.

The reason this development is so important is the nature of the LLC’s deemed state tax-exempt. In order to be state tax-exempt, an organization must be either a) a non-profit organization, or b) a specific type of for-profit organization set forth in Sec. 171 of the Texas Tax Code. The LLC’s that have qualified for state tax-exempt status do not fall into any of the classes that make up category b). Those categories include insurance companies (Tax Code Sec. 171.052), railway terminal corporations (Tax Code Sec. 171.053), open end investment corporations (Tax Code Sec. 171.055), businesses involved in solar energy (Tax Code Sec. 171.056), and a few types of cooperative associations set forth in Tax Code Sec. 171. Since only entities that fall in either category a) or b) can qualify for state tax exemptions, and several LLC’s with 501(c)(3) organizations as sole members have obtained state tax exemptions, then logically, the Comptroller must have concluded that the entities fall into category a) non-profit organizations. Again, just as in the case of the TDHCA finding that LLC’s can qualify as non-profit organizations, local political subdivisions of the State of Texas are bound by rulings and interpretations of state tax law made by the Comptroller. Tax Code Sec. 6.01(c) makes appraisal districts a political subdivision of the State of Texas, and thus bound by the findings of superior State agencies, such as the Comptroller of Public Accounts.

In addition to the foregoing, the Attorney General has opined in a way that is consistent with all of the foregoing, although in a slightly different vein. In JC-0015, March 19, 1999, then Texas Attorney General John Cornyn opined that a Texas limited liability company could be converted directly to a non-profit corporation by filing articles of conversion. One might well suppose that if the enabling statute of the limited liability company were inconsistent, in principle, with the notion of non-profit organization, this action would be precluded. However, the Texas Attorney General has opined that such a conversion is proper, and no further Attorney General opinions have been issued to alter that position.

I hope that the preceding information, citations, and legal arguments are sufficient to inform you that these LLC’s are deserving of treatment as non-profit organizations, and may be helpful in planning by considering the prospect of qualifying an LLC as a tax exempt entity. Once so determined, the LLC is not only exempt from federal income tax (as it is disregarded as an entity apart from its federally tax exempt sole member), but is exempt fron Texas franchise tax. Likewise, an LLC with a tax exempt solemember may qualify for sales tax exemptions as well by relyiong on the sole memebr's status. That will be addrsssed in a separate Legal Guide. if you have questions, feel free to contact us at [email protected].

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